Is Trust a Crucial Factor in Business Success? (Part II)

Running a small business in a developing country is tough. Many entrepreneurs have little education to operate their business efficiently. They have also to do it in a difficult environment; full of predators –such as customers that do not want to pay their purchase, employees that leave with equipment and creditors that charge exorbitant interest rates. Many of those problems are rooted in the lack of trust (see part 1). Unfortunately, in most developing countries, traditional channels of regulation and trust between people and businesses have not yet been replaced by alternative mechanisms. This has to change.

A great many odds In the industrialized world, small firm owners are generally more educated and wealthier than the average citizen. In the US, they are about three times richer. Entrepreneurship is by choice, especially for those who have the initial assets, and this self-selective mechanism ensures that small firms do expand as their owners are also the people most capable to make them succeed.

By contrast, in developing countries entrepreneurship is not a choice for the vast majority. It is often their only option for economic survival. For this reason, the rate of entrepreneurship is four times higher in Uganda and Tanzania than in the US or 10 times higher than in France. (Tanzania National Panel Survey 2010/11) However, these entrepreneurs have little education and suffer severe cash constraints and limited access to credit. These factors explain why so much attention is devoted to improving entrepreneurs’ assets and capacities, mostly through skills development and better access to credit. The most successful programs appear to be those that have targeted young entrepreneurs by combining both training and financing programs.

Furthermore it has been well reported that most developing countries, including Tanzania, are at the bottom of the World Bank’s Doing Business rankings. And contrary to widespread belief, informal firms are also on the radar of many government officials, especially at the local level. A businesswoman like Victoria, while not registered officially, is nonetheless required to pay multiple fees, legitimate or otherwise, to various agencies ranging from the Tanzania Revenue Authority to municipal and local authorities.

Small firms are also faced with high operational costs, especially transportation, which prevents them from attaining the best combination of skills and other resources at their disposal as well as to reach out their customers. The average congestion cost in Dar es Salaam is today estimated to be equivalent to US$20 per person per month (about 30 percent of the average monthly salary earned by a worker in Dar).

Recognizing the significance of small businesses for an economy, many governments, including Tanzania’s have faced up to these challenges and taken diverse measures to try and address them. These efforts have also been aided by other developments such as the recent explosion of mobile telephony in Tanzania which has contributed greatly to shortening of distances thus making things altogether easier for small businesses.

The trust (distrust) challenge…

But the challenges presented by the inherent distrust pervading the environment are unique – and presumably harder to mitigate. If these challenges are acknowledged at all, it will be to simply attribute them to cultural hang-ups – which are another way of saying nothing can be done about them. Yet, distrust is a critical issue for Tanzania as with most developing countries because of two interconnected trends: (i) the urbanization process which tends to eliminate or render the traditional channels of regulation and trust between people less effective; and (ii) the quasi-absence of the rule of Law.

Rules of the Law is low in the developing world
Restoring trust in the operating environment is a long term effort and there is no straight route to take. In every society, there are mechanisms to ensure the implementation of collective rules and to sanction trespassers. In the US, a strong justice system and accompanying institutions play this role with reasonable effectiveness. In France, this is ensured by collective groups, such as public employees, labor unions, and business associations. In China, the combination of central power and cultural heritage offers those safeguards.

In a country like Tanzania, if traditional mechanisms are still at play in rural areas, they have been vanishing in urban centers because of difficult living conditions (for example, inequality is more visible and space much more limited) in addition to external influences. Unfortunately, these mechanisms have not been replaced by other options as the majority of Tanzanians do not trust the institutions that are supposed to protect them. In 2009, almost 90 percent of Tanzanians believed that the police force and judges were corrupt. For what it’s worth, this kind of situation only makes people less inclined to follow the law. It also points to the urgent need to restore confidence in the police and justice systems. For, if the rules do generally exist on paper their implementation has hitherto not been consistent. And this has to change with a sense of urgency if small firms are to become the drivers of growth and employment that they really ought to be in developing countries.

Comments

The points you raise about mistrust of government are crucial, and lack of government credibility can undermine the impact of even the best intentioned reforms. The 2009 MENA PSD Flagship Report ("From Privilege to Competition") finds: "[D]iscretion and favoritism can weaken the public institutions that implement private sector policies and the credibility of government commitments to reform. Both hurt the expectations of investors and limit investment, competition, and innovation. The challenge for the governments is to implement policies that give clear signals to investors and strengthen their credibility as they work to level the playing field for all investors." Further: "The credibility of governments and the signals they send to firms are central to entrepreneurs’ investment decisions. The current rules and policies and how they are implemented matter for firms, but anticipation about how these will evolve in the future are also crucial to assess the expected risks and returns of investments."
Finally, it is important to understand that mistrust runs both ways: "Almost 60 percent of public officials interviewed across the [MENA]region thought the private sector in their countries was rent seeking and corrupt. Only 21 percent claimed it is dynamic, and 9 percent thought it was transparent and law abiding. The distrust is reciprocal. It is rooted in the belief by officials that a small group of rent-seeking firms dominate the private sector—a group that has long been protected by all sorts of barriers to entry. Among the negative behaviors cited are the bribing of civil servants, lobbying for special benefits and tax exemptions, hiding of revenues and salaries to avoid tax obligations, and nontransparent corporate governance. On the private sector’s side, it is also rooted in the belief that governments do not act to improve the investment climate for all businesses, but rather for the benefits of politicians and a narrow group of their allies."